Ok Boomer

Barron's wrote about boomers having too much equity exposure for being on the cusp of retiring or being newly retired. They are making a sort of sequence of return risk point. The article featured four advisors and what they say to clients who have too much in equities. 

It seemed like one of the advisors answered with a sort of sales pitch, one guy is a total jerk and the other two, regardless of whether you agree with them or not, sincerely tackled the question. 

This has long been a favorite subject to write about, it's a real portfolio construction challenge to be solved. Bonds went on a 40 year run where rates declined, causing bond prices to rise. It got to the point where with no yield to speak of, bonds looked more like equities than what people tend to think of for how bonds should perform. That 40 year run favorably skewed a lot of backtests and I would submit, skewed the results of the 4% rule for retirement withdrawals. Sitting here today, it is important to understand that it is not mathematically possible for that 40 year run to be repeated. When can have that discussion if bond yields ever get up to 15% again.

If you own any fixed income, what do you hope it will do for your portfolio? If you own individual bonds, the desired end result is that you get back 100 cents on the dollar. Whether you buy it at a premium or a discount to the par value you're getting the prevailing market interest rate. Yeah, maybe a small capital gain or loss might have utility for you somehow or if you paid par for a 20 year issue and it gets to 120, then it might make sense to sell but is that what you're expecting going in?

I want yield with as little price volatility as possible. Keeping maturities with individual issues and funds mostly short term delivers that even if with funds it is somewhat relative. I've been saying for awhile that intermediate and longer term maturities have become sources of unreliable volatility. If that is correct then putting 40% of a portfolio into longer term bonds might not be the protection against equity volatility that it use to be. I would say it is definitely not.

Putting 40% in 1-2 year paper yielding in the high fours to low fives probably accomplishes the little to no volatility objective but you have to understand the risk of that which is reinvestment risk, the risk that two years from now rates are much lower. If short rates stay where they are forever (not realistic of course) then you could roll the maturities forever keeping them short and reliably protecting against equity market volatility and addressing sequence of return risk. 

Addressing sequence of return risk and making sure expected income needs aren't disrupted regardless of what markets are doing is certainly a top priority close to or in retirement and I would argue the top priority. Markets come back, that is their nature, but "sorry, it would be a bad idea for you to take normal withdrawals for a while" isn't something you can get back.

There are many valid ways to get money out of your accounts. Have some number of months worth of expenses already raised in cash. Six months, 12, 24, whatever number makes you comfortable. Where possible I try to lean to more months expenses in cash not less. If stocks are going up and you sell some to keep in balance, that seems ok to me but I would think about tax consequences and try to offset where possible. If you own something that is intended to go up when stocks go down, then selling that holding when it is up, when stocks are down seems timely and you'd be increasing your net exposure to equities after a large decline. You can hold alternative strategies that are intended to trade sideways much like T-bills. You're not permanently impairing your capital by selling something that has traded sideways, exactly as intended. 

Selling stocks that are down a lot is not ideal under any circumstance. You aren't necessarily permanently impairing your capital because stocks have always come back and gone to new highs. Sell too much and yeah, that's real damage but if you panic out of 5% of your equity holdings, you've made a bad trade but haven't broken anything. 

Bonds are more difficult. I've seen some accounts lately (not my clients) that are heavy in exactly the types of maturities I've been saying to avoid for the last 15 years. They are down 20-30% getting below market yields. Time will bail out those positions when they eventually mature at par but that is a long stretch to get what are now crappy yields. Selling paper due in the mid 2030's at 77 cents on the dollar is probably a true permanent impairment of capital. There could be a way to trade around it if prevailing yields were close to current levels closer to maturity and of course if prevailing yields were to some how go back down to all time lows again, that would also bail out that type of position. Either way, that's a lousy way to manage sequence of return risk. 

I believe it is poor long term portfolio strategy to meaningfully lighten up on equities close to retirement or early in retirement, like in the first half of retirement, whatever that might mean to you. Manage for cash needs, absolutely, but undercut equity exposure too much, no, unless you're way ahead. 

At 63, planning to retire at 65 thinking you need $1,200,000 and you have $1,400,000. You have a nice buffer, you're not way ahead. Assuming this person is relying on their $1.x million for income, a gross underweight to equities is a very risky proposition. This person probably doesn't need 70% in stocks but I'd say 20-30% is way too low...again assuming this piece of money plays a big role in the retirement plan. I'd go with a normalish allocation to equities to get some growth and as we've learned in the last couple of years, the wrong kind of bonds can permanently impair capital which is the last thing someone on the verge of retiring needs. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.